Accounting - Term 4 - Week 8

Imagine Thandi runs a spaza shop in Soweto. She wants to buy a generator to cope with load-shedding, but isn’t sure if she can afford it. Her financial statements—her Income Statement and Balance Sheet—hold the answers. These documents show how much profit she makes, what she owns, and what she owes. For example, if her net profit is R12 000 and her debts are R20 000, she needs to think carefully before taking on more expenses. Financial statements help business owners, banks, and investors make smart decisions. Many learners think these statements are only for big companies, but even a small taxi business in Khayelitsha uses them to survive tough times. The key is understanding what the numbers say about the business’s health.

Sipho, who runs a minibus taxi fleet in Durban, wants to know if his business is making enough profit and can pay its debts. Accountants use ratios to get quick answers. The gross profit ratio shows what portion of sales is left after paying for goods sold. The current ratio tells if the business can pay its short-term debts. For example, if Sipho’s current assets are R30 000 and current liabilities are R15 000, his current ratio is 2:1, meaning he has twice as many assets as debts due soon. Many learners mix up profitability and liquidity ratios. Remember: profitability is about making money (like net profit percentage), while liquidity is about having enough cash to pay bills (like current ratio).

Lerato in Polokwane sees her business’s net profit percentage drop from 20% to 10%. She panics, thinking the business is failing. But her sales doubled, and she invested in new equipment. Ratios must be read in context—compare them to last year, to similar businesses, and consider outside factors like load-shedding or petrol price hikes. A common misconception is that a high current ratio is always good. But if most assets are unsold stock, the business might still struggle to pay bills. Always check what makes up the numbers. For the NSC exam, you must explain not just the ratio, but what it means for the business’s future.

Step 1: List current assets (cash, inventory, debtors). Ahmed’s Hardware in Mthatha has cash R5 000, inventory R10 000, and debtors R3 000. Total current assets = R5 000 + R10 000 + R3 000 = R18 000. Step 2: List current liabilities (creditors, short-term loans). Creditors R6 000, short-term loan R2 000. Total current liabilities = R6 000 + R2 000 = R8 000. Step 3: Divide current assets by current liabilities. Current ratio = R18 000 ÷ R8 000 = 2,25:1. This means Ahmed has R2,25 in current assets for every R1 of short-term debt. Step 4: Interpret the result. A ratio above 2:1 is generally healthy, but Ahmed should check if his assets are easily converted to cash. Final answer: Ahmed’s current ratio is 2,25:1. Sanity check: He has more than double the assets needed to pay short-term debts, which suggests good liquidity, but he must ensure these assets are not just unsold stock.

Step 1: Find net profit and sales. Net profit is R36 000, sales are R240 000. Step 2: Divide net profit by sales. R36 000 ÷ R240 000 = 0,15. Step 3: Multiply by 100 to get a percentage. 0,15 × 100 = 15%. Step 4: Interpret the result. This means for every R100 in sales, the shop keeps R15 as profit after all expenses. Step 5: Compare to previous years or industry averages for deeper insight. If last year’s percentage was 12%, the business is improving. Final answer: Net profit percentage is 15%. Sanity check: The calculation makes sense, as the profit is a realistic portion of sales for a retail business.

Question: Sipho’s Taxi Service has current assets of R12 000 and current liabilities of R8 000. What is the current ratio? Let’s think: The current ratio tells us if Sipho can pay his short-term debts with his available assets. Current ratio = current assets ÷ current liabilities. Worked response: R12 000 ÷ R8 000 = 1,5:1. Sipho has R1,50 in assets for every R1 he owes soon, which is fairly safe but not excessive. Now you try: If Sipho’s current assets were R16 000 and liabilities R8 000, what’s the ratio? Answer: 2:1. This means he is even more able to pay his short-term debts, which is a positive sign for his business.

Question: Thandi’s Spaza made R8 000 net profit from R50 000 sales. What is her net profit percentage? Model: Net profit ÷ sales × 100 = percentage. Worked response: R8 000 ÷ R50 000 = 0,16 × 100 = 16%. This means for every R100 in sales, Thandi keeps R16 as profit. For you: If net profit is R6 000 and sales R40 000, what’s the percentage? Answer: 15%. This shows a slightly lower profitability, but still healthy for a small business. Always compare to previous results to spot trends.

1. List two types of financial statements used by businesses in South Africa, such as the Income Statement and Balance Sheet. 2. Define 'current assets' and provide one example, like cash or inventory. 3. State the formula for net profit percentage and write it out in words. 4. Give one reason why financial statements are important for small businesses in places like Soweto or Khayelitsha. 5. Name one difference between assets and liabilities, using a real-life example from a local business.

1. Calculate the current ratio: Current assets R18 000, current liabilities R9 000. Show your working and explain what the answer means for the business’s ability to pay debts. 2. Calculate net profit percentage: Net profit R4 500, sales R30 000. Show all steps and interpret the result in a sentence. 3. Explain what a current ratio of 1:1 means for a business, and discuss if this is risky or safe. 4. Identify one possible reason why a business’s current ratio might suddenly drop, using a South African example. 5. Describe a scenario where a business’s net profit increases but its net profit percentage decreases.

1. Interpret: A business has a net profit percentage of 8% this year, down from 15% last year. What might this mean about its performance and what should the owner investigate? 2. Calculate: If a business has inventory R20 000, debtors R5 000, cash R2 000, creditors R10 000, and short-term loan R4 000, what is the current ratio? Show all calculations and explain what the answer means for the business’s liquidity. 3. Justify: Why should a business not rely only on the current ratio to judge its liquidity? Give an example of a possible hidden risk, such as having most assets in slow-moving stock. 4. Analyse: Compare two businesses—one with a current ratio of 3:1 and net profit percentage of 5%, another with a current ratio of 1:1 and net profit percentage of 18%. Which business is healthier overall and why? 5. Predict: If a business in Durban faces regular load-shedding, how might this affect its financial ratios over time? Explain your reasoning.

• Net profit percentage
• Current ratio
• Return on equity
• Gross profit percentage

Answer: Current ratio

Current ratio measures liquidity—how easily a business can pay its short-term debts. The others measure profitability.

• 1:2
• 2:1
• 1:1
• 3:1

Answer: 2:1

Divide R24 000 by R12 000 to get 2:1. Some learners reverse the ratio, but assets come first.

• The business makes R20 profit for every R100 sales
• The business owes R20 for every R100 assets
• The business sells 20% of its stock
• The business has 20% more assets than liabilities

Answer: The business makes R20 profit for every R100 sales

Net profit percentage shows how much profit is made from sales. A 20% net profit percentage means that for every R100 the business earns in sales, it keeps R20 as profit after all expenses. The other options confuse profit with assets or sales volume.

• The business has more current assets than liabilities
• The business may struggle to pay short-term debts
• The business is highly profitable
• The business has no debts

Answer: The business may struggle to pay short-term debts

A current ratio below 1:1 means the business has less in current assets than it owes in short-term liabilities. This can lead to cash flow problems and difficulty paying suppliers or creditors on time, even if the business is profitable.

• Inventory
• Debtors
• Equipment
• Cash

Answer: Equipment

Equipment is a fixed asset, not a current asset. Current assets are expected to be converted to cash within a year, like inventory, debtors, and cash. Many learners confuse equipment with current assets, but it is used over several years.